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Runway and the pitfalls of “by the book” metrics

A successful fundraising process requires a company to pitch how much money it needs to fulfil its plans, how this money will be used and how it will enable the company to achieve its ambitions, whether this is breaking even, raising a new round or something else.

Once the money is through the door, are companies properly tracking spending and the financial impact of their decisions? Are they checking that their plans are matching reality? Are they well-positioned to reach the milestones they need to hit to raise their next round, if that’s a part of their plans?

Simply tracking spending - and forecasting based on previous spending- often presents skewed realities. This is because financial/accounting metrics do not always fully reflect the actual position of a company. It can be particularly tricky to decipher when financial metrics are not properly designed and managed from the outset.

Runway is one of the key metrics used when analysing a startup/scaleup’s financial position. The term ‘runway’ comes from an aviation analogy - runway is the strip where planes gain speed to take off. If the plane can’t achieve sufficient velocity with the available runway, they won’t be able to take off and will get into difficulty.

Image credit: Shutterstock

In the financial world, runway is a measure of how much time a company has before a) becoming cash flow positive, b) accessing a new round of funding or c) running out of money.

Runway is typically denoted in units of time, usually months - for example, ‘we have 15 months of runway’. The formula usually used to calculate it is:

Runway (in months) = Cash (and cash equivalents) / Cash Burn Rate (per month)

Cash balance is the amount of cash that a company has on hand at a given date.

Cash burn rate is the actual negative cash flow a company is experiencing based on its actual expenditures/collections for the preceding period (last month or average of last 3 months).

However, a key aspect is usually ignored in the calculation: Like most financial metrics, it looks to the past while the future is ignored. Whilst runway appears to be a static metric, complications often arise because, in a growing company, the size of the aeroplane and the strip are not constant.

To illustrate, if a company is hiring in the upcoming months and the collection (accounting speak for ‘cash in-flow’) from customers is not growing, the cash burn rate will increase - i.e. the runway will shorten from, for example, 12 months, to 8 months in a single month based on changes in projected spending. And, in some geographies, payment of payroll taxes for a given month can be (and often are) delayed until the following month, meaning that when a new employee is hired, part of the effect is seen in the same month (net salary paid) and the rest with a “delay” of one month.

If a company had £120k in the bank as of December 31 2022 and was burning £10k per month, using the formula above one would say that the company has 12 months of runway. If the same company hired an employee to start on January 1 2023, with an annual salary of £60k and keeping the collections and other costs constant, the burn would be increased by approximately £5.7k per month (as the annual cost of this employee to the company, after national insurance and pension costs are approximately £68.5k). This would decrease the runway to less than 8 months - cash burn rises from £10k per month to £15.7k per month, reducing the 12 months of runway to <8.

On top of that, not all future expenditures are easy to track or foresee, especially in companies where there is no specialised finance function or where financial closing is not done monthly. In a company with timely accounting period-end closing, you can find future payments for existing agreements under liabilities on the balance sheet but this is not the case most of the time.

By calculating the runway in a conservative and more detailed way, it can express a realistic view of when the company is going to actually run out of cash. This could be done by factoring in planned actions to extend the runway and being more transparent about including future expenditures that will consume the cash on hand available for operations.

One of the recommended ways of doing this is to have a high-quality, recurring and timely analysis of Actuals, Budget and Forecast. By replacing the budget/forecast by actual amounts after month-end, one can see how the forecast will change and when the company is expected to reach breakeven (or run out of cash).

The idea behind reporting this metric is to present a clear and accurate view of when a company is going to run out of funds to maintain its operations - of course, this can be particularly tough in an ever-changing internal and external environment.

In a scenario where most fundraising processes are taking at least 6 months to be concluded, much like the current environment, both founders and investors should avoid surprise shortenings of runway and realise that funds are gone before the expected date.

Ideally, companies should create scenarios with different actions to extend the runway and be able to action them to secure their continuity when times are challenging. There are many different ways in which a company can extend its runway or postpone a funding round for a certain period, among those there are: cutting costs, raising debt (including credit lines), renegotiating supplier payment terms, factoring, and others.

Conversely, these scenarios could reflect how runway may evolve in sunnier times, too!

The bottom line is that it is important for companies to have a firm grasp of how long they can keep operating without accessing new funds, particularly VC-backed companies where the modus operandi is to run as fast as you can to realise your opportunities. Therefore, our advice is to err on the side of caution, be conservative and pay attention to future obligations when calculating and forecasting this KPI.

If you would like to learn more about runway and other Finance topics, please join our Brighteye Edtech Startup Festival for the Session on Finance on Thursday 7 September - sign up here!

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